Posted by CHEN Tiancheng, Year 4 undergrad at the School of Accountancy, Singapore Management University

Should Employers Offer Financial Incentives for Whistleblowing

It is well known that many employees do not blow the whistle for fear of repercussions if they do (from harassment to dismissal and various poor treatment in between). So should we offer incentives to employees to follow a whistleblowing procedure, in order that health and safety breaches and other illegality can be promptly brought to employers’ attention and swift remedial steps taken?

In the US the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act features an incentivised whistleblowing procedure relating to whistleblowing in the financial services sector.

In 2014 two of the UK’s top financial regulators, the Bank of England and the Prudential Regulation Authority, looked into providing incentives for making protected disclosures in the financial services sector in the UK. The recommendation they made to Parliament, following their investigation, was that a State programme to reward whistleblowers should not be implemented.

This means that Parliament will not be introducing any law on the State offering financial incentives to individuals who whistleblow in the financial sector. But this would not prevent employers in that or other sectors introducing their own incentives for whistleblowers.

But should they? What can be learned from the research conducted by the financial services regulators?

Reasons against offering incentives
1.The cost – there is no way of assessing how high the cost of paying out these financial incentives could be. In the US under Dodd Frank the amount paid to whistleblowers is 10 – 30% of the fine ultimately imposed by the enforcing Commission there, providing it exceeds $1m. Consequently, significant sums of money could potentially be paid out. There would be no obligation on a UK employer to match that but even relatively minimal financial incentives are still an additional cost to the business, which few companies can afford in the current economic climate. If we assume that fear of retribution, dismissal, etc., would otherwise deter the employee from blowing the whistle, it is obvious in addition that a purely nominal incentive is not going to be enough to get him over that concern. An incentive scheme not generous enough to make any difference might have its cosmetic attractions, but in practical terms is really not worth having.
2.It could be complex – how will the amounts of any award be decided, will it only be paid on a successful investigation, will there be a minimum bar that has to be hit before a payment is made? It could get complicated. The US system is a ratchet off a penalty but the proper aim of whistleblowing should be to get wrong-doing stopped, not necessarily punished. What price do you attach to a disclosure which has no monetary impact?
3.It could undermine the introduction and maintenance by companies of effective internal whistleblowing mechanisms, which should be encouraged as good employee relations practice. You should blow the whistle because it is the right thing to do for the good of your employer, not because you may have something to gain from doing so.
4.It might encourage malicious reporting, prompting employees to entrap others into breaking the law so they could collect a reward or simply to make a speculative claims of wrongdoing in the hope of some reward.
5.The cash recipient could in some cases be the perpetrator.
6.Giving material rewards to whistleblowers could damage their credibility during an internal investigation in court by calling their motives into question.
7.Under Dodd-Frank the scheme provides little or no incentive to whistleblowers whose information does not lead to an enforcement outcome. How could that work in a company scheme? Would a payment only be made if information led to a dismissal, for example? Or a lesser sanction? Will there not be a sufficient protection for whistlebowers under existing company policy?
8.There is a strong view that this sort of scheme is giving money to employees for performing what is arguably their duty anyway, like an additional incentive for turning up on time or not performing badly.
9.Given that UK law already provides uncapped financial remedies to those suffering retaliation for whistleblowing, is an additional incentive really needed?
10.Finally, the research concluded that a financial incentive scheme is unlikely to increase the number or quality of disclosures, which is a fairly damning conclusion. While it is possible to envisage that a very generous scheme might increase disclosure numbers, it is equally likely that this would be accompanied by a drop in disclosure quality.

So what should employers be doing instead?

The advice from the Bank of England and Prudential Regulation Authority research, which will be published later this year is that:
1.strong measures are needed to encourage and protect whistleblowers; and
2.there is a need for a culture change to help improve behaviour and value the opportunity to improve senior management accountability for whistleblowing.

We will have to see how this translates into concrete proposals that employers can implement. Until then, companies should be looking to have strong whistleblowing policies and procedures to protect employees who blow the whistle and also for key staff to be trained on dealing with whistleblowing complaints, maintaining confidentiality and protecting the whistleblower.

I bet cunning corporate pooh-bahs who have stolen from a company, ripped off shareholders or bilked the government fear most a visit from a Securities and Exchange Commission regulator.

If so, their worries may be misplaced.

The SEC surprisingly is just a minor player on the fraud-busting front. Chances are, any corporate shenanigans coming to light will be from a trusted aide or embittered employee- turned-whistle-blower.

If not them, then from those pesky short sellers, who also have a knack for uncovering corporate malfeasance. And don’t forget the analysts whom executives butter up and then cozy up to. A soon-to-be released study in The Journal of Finance titled “Who Blows the Whistle on Corporate Fraud?” found that in hundreds of corporate fraud cases employees, short sellers and analysts were the primary whistle-blowers.

“These players do not appear in traditional discussions of corporate governance, but the data suggest they should,” said Adair Morse, assistant professor of finance at the University of Chicago’s Booth School of Business and one of the authors of the report.

Morse and the other researchers analyzed 216 cases of corporate fraud from 1999 through 2004, including the Enron, WorldCom and HealthSouth cases. They found that employees were the whistle- blowers in 17 percent of the cases – the highest percentage of any of the players.

Short sellers ranked second, uncovering the fraud in 14.5 percent of the cases. Analysts were third, with 13.8 percent. The SEC detected only 6.6 percent.

Given what happens to employees when they bring fraud to light, it’s surprising that any of them come forward.

“Their lives are damaged terribly,” Morse said. “They often lose their jobs. They sometimes have to leave town because when frauds come to light there are usually layoffs.”

One powerful motivator, however, is money. The Federal Civil False Claims Act states that when fraud is committed against the government, such as in Medicare fraud cases, the whistle-blowers are entitled to between 15 percent and 30 percent of the money recovered.

Because of that law, some 41 percent of the fraud cases in the health care industry are brought by employees, Morse said. So basically if you want employees to step up in fraud cases “you have to pay them to go into retirement.”

Short sellers obviously have a huge monetary incentive to disseminate negative news to the market because they profit when stock prices drop. But to the extent that they uncover fraud, they are beneficial players in the system, Morse said, even though most executives despise them.

The monetary incentives for analysts are a bit more indirect but still very significant. Whistle-blowers in this field are much more likely to receive the prestigious “All American” analyst ranking given each year by the Institutional Investor magazine.

These top-ranked analysts are then courted and recruited by the big investment banks, and that means higher salaries for them, according to the study.

I asked Morse if she became discouraged and cynical slogging through all these corporate fraud cases.

She thought for a moment and then said: “No, not really. My goal was to level the playing field for investors so when they are putting their money away for retirement they trust the system.”

Guest Speaker Mr. Hemant Amin, Founder, Chairman and CEO of Asiamin Capital, a single family office, and Founder and Chairman of the BRKets investor groupMarch 17th, 2015

Hemant, a big thank you for educating and inspiring the next generation of leaders. You are a rare positive role model in the Asian capital markets and you showed the students that it is possible to create value because one has the right values and mindset like Buffett and Munger! :)